Monday, December 17, 2007

Stock Market Update 17 December 2007

It was a very interesting week in the markets last week and where we go from here is somewhat cloudy.

The highlight was the FED meeting on Tuesday where they announced they would cut both the FED Funds rate and the Discount rate (the rate the FED charges the banks if they come looking for a loan, also known as the "discount window") by 25 basis points each (1/4%). The market was expecting a 50 basis point (1/2%) cut on both rates and when it didn't get what it wanted it threw a temper tantrum.......stock prices plunged.

The following day the FED announced it was joining with 4 other Central Banks around the world to offer "liquidity" to banks via a new central bank auction function.

Without all the mumbo-jumbo; here is essentially what is happening:

-banks do not trust each other because of the SIV problem and all the mortgage issues I detailed previous

-because they don't trust each other, they are not willing to lend to each other

-when this happens, the flow of money ceases and a deflation occurs

-banks can still go to the FED as a "lender of last resort", but any loan they get from the FED through the discount window is required to be public knowledge......therefore any bank that goes to the FED for a loan is essentially broadcasting to the world they are in financial difficulty....what bank wants to do this? instead of working to fix the problem the banks are sitting on their hands and hoping for the best (preserving their cash) while looking to the government (FED) to do something to help them out. This the FED did in the announcement of the new forthcoming Central Bank auctions.

The 5 central banks (U.S. Central Bank, U.K. Central Bank, European Central Bank, Bank of Canada, Bank of Switzerland) will be offering $80 billion in 4 auctions ($20 billion per auction; the first of which occurs today) in an attempt to provide liquidity into the system to get the credit processes moving again. They will accept basically anything of "value" (including those mortgage backed securities that have unknown value) in exchange for a loan. In addition, unlike the loans from the discount window, these loans will not be public knowledge so you won't know which banks are in trouble and needing these loans. Neat way to circumnavigate the existing laws that require the credit system to provide full disclosure to the public.

In any case, there is a huge amount of uncertainty in the markets right now. However I am comfortable the charts have kept me in the right place for now.

First chart is the DJW 1 year line chart (click charts to enlarge):

The key thing to note is while the price advanced from the mid-November bottom and broke through the 50 day moving average, it did so without the ADX (14) green line having extended above 60. This indicated to me that while price was rising, the underlying demand structure was not supporting the rise (in other words; the dumb money was buying while the smart institutional money was not). As such, the move was somewhat suspect.

Note the bottom of the mid-November price was 292.17. Any close below this point would be a "lower high, lower low" and would indicate a bearish declining price scenario. More on this next.

Next chart is the PNF 1 box chart:

This chart went "bullish" on the price break above 305. Normally had the line chart previous confirmed the move, I would have moved to a more aggressive equity position but since the line chart did not confirm, this move is somewhat suspect.

The key to note here is the current structure is a series of "O"s...... a continuation and break below 293 (ie. a price print of 292) would change this chart to bearish.

Next chart is the PNF traditional:

Here too the current trend is bullish. However, note this chart has formed a series of "O"s. This unto itself is not a big deal (normal in a rising market) but what is important is this chart would turn bearish on a price close in the next block below that which it currently is at and that is........292.

So we have 3 independent charts that indicate that a price break below 292 would be a very negative indication of a trend breakdown (both short term and medium term).

Final chart is the weekly chart back to the start of the bull market rise:

This chart still looks ok as long as the 13 week ma does not cross the 34 week ma. Should this occur it would be a tremendous indication things are turning for the worst.

Bottom Line:
The markets are at a crossroads:

"Glass half full" view:
In spite of all the banking mess over the past 2 months, the markets have failed to fall. They are still holding their own which is amazing given all that has been thrown at them.

"Glass half empty" view:
The markets have yet to see the real impact of the sub-prime fiasco. The mortgage rate resets next spring/summer will be huge......there is a very real chance at least one major bank will fail and the U.S. will go into recession.

My position remains unchanged:
50% equities
25% Euro
25% USD

Should the DJW close below 292 I will reduce my exposure to 25% equities. Any 13/34 cross on the weekly chart and I will be 100% in cash.

Any closing price above 312 and I'll go to 75% equities as long as the line chart confirms the move. Any closing price above the all time high at 320 and I will move to a 100% long equity position.

Any moves I make will be blogged as soon as I have decided to make them.


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